BUSINESS VALUATION ( IN BRIEF)

BUSINESS VALUATION

Definition : Business Valuation is a process and set of procedures used to determine the economic value of an owner's interest in a business.

Why Business Valuation ? 

Business Valuation Purposes / Need for Business Valuation : 

• Mergers & Acquisitions
• Takeover
• Demerger
• Financial Reporting
• Buy/Sell Agreements
• Addition or retirement of a partner
• Public Issue
•  Share Pledge
• Taxation Dispute
• Restructuring the business
• Business planning & value added management
• Wealth Planning
• Will plannig
• Goodwill impairment
• Applying for loan
• Liquidation & Filing  for bankruptcy
•  Tax planning  

Steps in Business Valuation :

• Identification of the purpose of Business Valuation
• Evaluate the company's strategic position, company's competitive advantages and disadvantages  in the industry.
• Develop performance scenarios for the company and the industry and critical events that are likely to impact  the performance.
• Forecast Income Statement and Balance Sheet line items based on the scenarios.
• Check the forecast for reasonableness.
• Estimating Discount Rate and Capitalization Rate 
• Estimating the WACC - Weighted Average Cost of Capital
• Preparation of Valuation Report
• Interpreting  the Results

Approaches to Valuation : There are three approaches to valuation viz.

1. Discounted Cash Flow (DCF)
2. Relative Valuation
3. Contingent Claim Valuation

Business Valuation Techniques :

The methods of valuation can be broadly categorized into three types, viz.

1. Balance Sheet / Asset Based Valuation :

This method of valuation is basically used in case of merger and acquisition while the target firm is running at loss. It is used when a company is asset intensive.The asset based valuation can be carried out on the basis of : i) Book Value ii) Replacement Value iii) Liquidation Value

   

    2. Market Based Valuation : 

This valuation reflects the price the market at a point in time is prepared to pay for the shares. This valuation method broadly takes into account the investor's perceptions about the performance of the company and the management's capabilities to deliver a return on their investments. The market based method can be further categorized into the following types ; i) Price Earnings Multiple ii) Market Capitalization of Listed Companies iii) Sales / Profit Multiple

    3. Income / Earning Based Valuation : 

 This valuation method is best used for non-asset intensive businesses like service providing companies. Valuation based on earnings, based on rate of returns on the capital employed is a more modern method being adopted. Income based method can be further categorized into the following types : i) Income capitalization, ii) Dividend Capitalization, iii)Discounted Cash Flow (DCF), iv) Discounted Earnings, v) Discount Rates & Capitalization Rates

Comparing valuation by different methods : 

Comparing Valuation by different methods can be quite informative, and a useful crosscheck of business value. If one method reveals a higher valuation than another, then it may reveal something about the business.
For Examples :

1. If the notional realization of assets valuation is greater than the earning multiple valuation, it implies that the business is either over capitalized or under performing.

2. If the discounted cash flow valuation is greater than the earnings multiple valuation, it may imply that the business is expected to substantially increase profits.

3. If the industry valuation is less than the earnings multiple valuation, it implies that the business is either over valued or industry leader.

Content of the Valuation Report :

The valuation report should include :

• Description of valuation engagement

1. Details of the client
2. Engagement - purpose of valuation
3. Form of valuation - In which function the valuation is being carried out
4. Valuation Effective date

• Description of business being valued

1. Legal background
2. Financial aspects
3. Tax matters / documents

• Description of the information underlying the valuation

1. Availability and quality of underlying data
2. Analysis of past results
3. Budgets with underlying assumptions
4. Review of budgets
5. Statement of responsibility for information received

• Description of Specific valuation of assets used in the business

1. Procedure carried out
2. The principles used in the valuation
3. Valuation method used
4. The procedures involved in making projections
5. The scope and quality of underlying data
6. The extent of estimates and assumptions together with considerations underlying them
7. The confidential figures must be summarized in a separate exhibit

References : "The Management Accountant" magazine issued by Institute of Cost Accountant of India.